Lessons on fund executive remuneration from North America

An examination of the salaries and pay structure of Ontario Teachers’ Pension Plan, arguably the world’s best pension organisation, supports the adage that you get what you pay for.

This is worth noting and considering locally. The 2018 Investment Magazine Super Fund Salary Survey, published in February, highlighted how more and more Australian superannuation funds
are rewarding their most senior executives via incentives. While this trend makes some local industry stalwarts uncomfortable, a look at the Canadian experience indicates the approach can deliver great value to fund members.

In 2016, Ontario Teachers’ Pension Plan (OTPP) paid staff more than C$360 million ($363 million). This is a huge number in anyone’s world. But when it comes to salaries, the OTPP story
is one of value, not absolute figures, and is a good case study for Australian investors.

OTPP has the advantage of being a relatively new organisation, at least compared with some pension funds globally, such as the largest fund in the US, the California Public Employees’ Retirement System (CalPERS), which is more than 100 years old. The benefit of this was a clean sheet of paper to design an organisation that can be fit for purpose and capitalise on governance best practice.

Since it was formed in 1990, OTPP has maintained many of the elements of what is now known as the Canadian model, including independence, strong governance, direct investing with world-class teams and the ability to attract and retain talent. These have been identified as tenets of good organisational design and investment practice.

The Australian superannuation industry is a similar age to OTPP but has grown up with more complexity, more legacy issues and in some areas more naivety around these tenets. The attitude towards recruitment and retention of talent in Australia is comparatively immature, for example.

OTPP argues that its people are its edge, and only through hiring and remunerating good investment professionals has it been able to implement the ideology that has made it so successful. The organisation has 80 per cent of its assets managed in-house.

OTPP is 105 per cent funded and has C$180 billion ($182 billion) in assets. The fund’s investment strategy is built on innovation and a bedrock of strict risk management, with a large allocation to private assets managed directly. Over the last 10 years, OTPP has returned 7.3 per cent against a benchmark of 6.3 per cent. Since inception, it has posted an annualised return of 10.1 per cent.

The top-performing Australian super fund over the 10 years to June 30, 2017 is REST, with an annualised return of6.2 per cent, Chant West data shows.

Salaries and incentives

OTPP’s investment expenses are dominated by salaries. In 2016, salaries for investment staff made up 64 per cent of investment expenses at OTPP – C$290.1 million out of a total investment expense of C$451.2 million, its annual report states.

OTPP paid a further C$33.1 million in compensation to key personnel, including the chief executive, chief investment officer and key investment staff.

That’s C$323.2 million in salaries, benefits and incentives.

To put this in perspective, the California Public Employees’ Retirement System (CalPERS) spent only US$69 million ($88 million) on investment salaries in 2017.

In trying to uncover value for money, it’s worth exploring the differences in these two funds a little further.

The US$345 billion CalPERS – which admittedly has a very different governance structure, including a lay-person board and having to adhere to the government-imposed cap on salaries – has the vast majority of its assets managed externally and does not have anywhere near as much in direct or private assets as OTPP. CalPERS has only 20 per cent of its portfolio in private equity and real assets, compared with OTPP’s 65 per cent.

In 2017, total investment expenses for CalPERS were US$871.3 million because, while internal investment personnel and administrative staff were paid US$69 million, CalPERS spent a whopping US$598.8 million on external investment managers and a further $6.6 million on consultants’ fees.

To be fair, CalPERS has reduced its external manager fees from more than US$1.34 billion in 2014.

But the point remains, on every measure, OTPP outflanks CalPERS: CalPERS’ total costs are much higher than OTPP’s; CalPERS is only 68.3 per cent funded; and its 10-year return is an annualised 4.4 per cent versus 7.3 per cent for OTPP.

Salary structures

In 2016, the chair of OTPP, Jean Turmel, received C$170,000 in compensation.

In the same year, fund CIO Bjarne Graven Larsen received C$3,153,728 and chief executive Ron Mock earned total compensation of C$4,087,974, making him the highest-paid executive in pension management globally (at least from what can be gleaned from publicly available information).

But it’s the way OTPP structures its salaries, including strict benchmarking and design principles, that makes this an interesting story.

The plan’s salaries are made up of a base, annual incentive plan (AIP), deferred incentive plan and long-term incentive plan (LTIP).

For senior leaders, a higher percentage of pay is variable.

For the chief executive and CIO, the mix is LTIP (37.5 per cent), AIP (37.5 per cent) and base salary (25 per cent).

Each employee’s incentive pay is designed around the risk budget and the board approves the active risk allocations, which establish performance goals for dollar value added each year. There are other design rules as well, like an upper limit on annual payments and clawback provisions for wrongdoing.

Further, in a feature that’s rare among pension funds, employees of OTPP have the opportunity to allocate all or part of their AIP to the fund for up to two years, aligning them with investment decisions.

Each year, a small percentage of the total fund’s net value added goes into an LTIP pool, which is allocated to individuals’ notional accounts. Each year, 25 per cent of individual account balances are paid to active employees.

So of chief executive Mock’s total compensation of C$4,087,974 in 2016, the largest component was the LTIP of C$2,208,000.

At the beginning of 2016, Mock’s notional account balance was C$7,237,730. The account earned 4.24 per cent, consistent with the total fund performance that year. In 2017, Mock was paid C$2,208,000 from this account and was left with a balance of C$6,623,805.

There’s no question the staff at OTPP are paid handsomely, but the incentive structure is a sophisticated alignment of interests.

This has produced stellar investment returns, reduced costs and sustained good performance. But the model is also successful by another measure of value.

In 2016, the average starting pension for an OTPP member was C$45,000, this is a shift from when the fund started, in 1990, when the average starting pension for a teacher in Ontario was C$29,000.

After all, it’s what goes back to the members that matters.

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